The UK is currently witnessing spiralling inflation – and don’t we all know it! Prices are rising almost everywhere we look, and higher National Insurance contributions, Council Tax rises and bigger energy bills are just around the corner.
And, if you’re hoping for any good news in the shape of a decent pay rise, you may be disappointed. That’s because the Bank of England has warned the cost of living crisis could get even worse if price rises are not ‘contained’. In other words, if wage inflation is too high, it could lead to problems for the wider economy.
So how does pay growth compare to the inflation rate? And what is likely to happen if wage inflation starts to accelerate? Let’s take a look.
[top_pitch]
What has the Bank of England said about wage inflation?
Last week, the Bank of England upped its base rate to help combat the UK’s rising level of inflation. Right now, inflation is running at 5.4% according to the ONS. Following the rise, the base rate is now 0.5%.
On the same day the bank raised the base rate, it’s governor, Andrew Bailey, suggested workers should ‘show restraint’ when asking for pay rises this year. Bailey has since faced a lot of criticism for his comments. That’s because some believe he is asking workers to bear the brunt of his bank’s inflation-causing policies.
Yet whatever you think about Bailey’s comments, he clearly believes pay growth can worsen the problem of rising prices. This is a point that was echoed by the Bank’s chief economist, Huw Pill, in a recent speech he made concerning the UK’s inflation rate.
Pill spoke about how employees seeking pay rises to keep up with inflation could be harmful to the economy. He explained: “The longer that firms try to maintain real profit margins and employees try to maintain real wages, the more likely it is that domestically-generated inflation will achieve its own self-sustaining momentum even as the external impulse to UK inflation recedes.”
Pill, who voted against raising interest rates to a higher 0.75% a week ago, also explained how his Bank’s existing policies assume pay rises will be ‘contained’. According to Pill: “Our baseline assumes that this risk of so-called second round effects will be contained, in part by the monetary policy measures taken and in prospect.”
However, Pill hinted that if wage inflation starts to accelerate, the Bank is likely to hike rates again. He explained: “…should this assumption come under threat or prove to be misplaced, a further monetary policy response would be required”.
[middle_pitch]
How does wage growth compare to the inflation rate?
According to the most recent data from the ONS, wage inflation was at 4.2% between September and November 2021, taking into account bonuses. Excluding bonuses, this figure drops to 3.8%.
This data highlights how wage growth is already failing to keep up with the UK’s inflation rate. Plus, when the ONS releases new wage inflation data, it’s likely to show that this gap has widened.
The ONS hasn’t revealed the date on which it will release new wage growth data. However, its updated Consumer Prices Index will be revealed on 16 February, which will tell us more about inflation.
Can rising wages worsen the cost of living crisis?
If you’re an employee, you’ll be forgiven for acting in your own interest when it comes to negotiating pay. If you do manage to secure a pay rise above inflation, you’ll be better off. It’s as simple as that.
However, if inflation-busting pay rises like this become commonplace, this can worsen the inflation situation. That’s because widespread ‘wage push inflation’ means businesses will have to start paying more for labour.
In such a scenario, the costs of producing goods and services increase. As a result, businesses generally increase their own costs in order to protect their profit margins. This can cause an inflation spiral and may indeed worsen the cost of living crisis.
To learn more about this topic, see our article that explores why traders are rushing to gold to protect their wealth from inflation.
